ADBI Working Paper Series
The Relationship between
Structural Change and Inequality:
A Conceptual Overview with
Special Reference to Developing
Asia
Joshua Aizenman,
Minsoo Lee, and
Donghyun Park
No. 396
November 2012
Asian Development Bank Institute
Joshua Aizenman is Robert R. and Katheryn A. Dockson Chair in Economics and
International Relations at the University of Southern California, co-editor of the Journal of
International Money and Finance, and research associate for the National Bureau of
Economic Research. Minsoo Lee and Donghyun Park are senior economist and
principal economist, respectively, at the Economics and Research Department, Asian
Development Bank.
The views expressed in this paper are the views of the author and do not necessarily
reflect the views or policies of ADBI, the ADB, its Board of Directors, or the governments
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Suggested citation:
Aizenman, J., M. Lee, and D. Park. 2012. The Relationship between Structural Change and
Inequality: A Conceptual Overview with Special Reference to Developing Asia. ADBI Working
Paper 396. Tokyo: Asian Development Bank Institute. Available: http://www.adbi.org/workingpaper/2012/11/13/5332.structural.change.inequality.dev.asia/
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© 2012 Asian Development Bank Institute
ADBI Working Paper 396
Aizenman, Lee, and Park
Abstract
Structural change has a far-reaching impact on inequality. It exposes the population to
challenges and opportunities. Foreign trade and technological progress have been widely put
forth as a structural driver of inequality. Broader structural change, such as demographic
transition, can also impinge upon inequality. Structural change in developing Asia has been
unprecedented in its scale and speed. The heterogeneity of the population implies that the
adjustment capacity to these changes varies. The fundamental solution to mitigating the
adjustment costs arising from structural change lies in empowering individuals to become more
productive, adaptable, and versatile through access to education and employment. Structural
change exerts a significant effect on inequality in both advanced and developing countries. The
experiences of the advanced economies entail valuable lessons for developing Asia. Extensive
structural change is both a cause and consequence of the exceptionally rapid economic growth,
which enabled developing Asia to raise living standards and reduce poverty at a historically
unprecedented rate. The region has already begun the difficult and complex task of addressing
inequality arising from structural change. There is a growing recognition that more sustainable
growth supported by broad-based political and social support requires a growth strategy, which
provides equality of opportunity, especially in education and employment. The newly developing
more inclusive growth philosophy envisions expanded social protection systems and social
safety nets to protect the poor and the vulnerable.
JEL Classification: O15, O53, P46
ADBI Working Paper 396
Aizenman, Lee, and Park
Contents
1.
Introduction ..................................................................................................................... 3
2.
Conceptual/Theoretical Overview of the Relationship between Inequality and Structural
change............................................................................................................................ 4
2.1
2.2
2.3
2.4
The Five Broad Time-Varying Channels Which Influence the Relationship between
Structural Change and Inequality .......................................................................... 4
Kuznets Curve ...................................................................................................... 6
Structural Change, Inequality, and Openness ....................................................... 7
The Influence of Other Factors: Education, Financial Inclusion, Infrastructure,
Governance and Institutions ................................................................................. 8
3.
Inequality-Structural change Nexus in the Advanced Economies.................................... 9
4.
Analytical Review of the Inequality-Structural change Nexus in Developing Asia ...........13
5.
Concluding Observations and Policy Implications ..........................................................17
References ...............................................................................................................................19
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1. INTRODUCTION
At a narrow level, structural change refers to changes in the structure of the economy. The rise
in the relative share of manufacturing is typically followed by a rise in the relative share of
services as the manufacturing sector matures and the economy moves into a post-industrial
phase. Asia-wide structural change has been economic globalization, or growing integration into
global trade and financial system. An indispensable core ingredient behind developing Asia’s
remarkable economic success has been the explosive growth of trade with the rest of the world
and with other countries within the region. Equally important to the region’s rapid growth has
been the large inflows of foreign direct investment (FDI) and other foreign capital into the region.
The region has now become a globally significant exporter of capital and such capital outflows
will benefit its growth. Another Asia-wide structural change is technological progress, which has
steadily shifted the region’s technological level toward the global technology frontier. While our
study looks primarily at the newly-industrialized economies (NIEs), middle-income economies
such as Malaysia, the People’s Republic of China (PRC), and India, much of the analysis has
relevance for the rest of developing Asia as well. However, some qualifications have to be made
for country-specific characteristics—e.g., transition from central planning to markets.
At a broader level, structural change encompasses social, political, cultural, societal, and other
changes. Many countries in developing Asia, most notably the PRC but also Mongolia,
Indochinese countries and former Soviet republics in Central Asia, are in the midst of a
transition from centrally planned economies to market-oriented economies. While this transition
clearly has far-reaching economic implications, it is much more than a narrow economic shift
since it entails a drastic change in the relationship between the state and the citizens and
indeed in the mind set and world view of individuals. There has also been a gradual shift toward
more open and pluralistic forms of government throughout the region. Family structure is also
undergoing a major shift in the region. Developing Asia is currently experiencing a seismic
demographic transition, which will result in substantially older population age structures in the
future.
There is a great deal of interaction between different kinds of structural changes, both narrow
and broad; therefore, it is unproductive to think of each structural change in isolation. It is
instead conceptually more useful to think of structural change as a constellation of a wide range
of economic, political, social, and other factors, which collectively alter the structure of the
economy and the society at large. For example, large-scale migration of rural workers to urban
areas contributes to the change in family structure from extended families to nuclear families. At
the same time, the same phenomenon accelerates the trend toward urbanization and the
expansion of manufacturing and services sectors. What is unique about structural change in
developing Asia is its sheer scale and speed due to the region’s exceptionally rapid economic
growth and development. In fact, far-reaching structural change has been both a cause and
consequence of historically unprecedented growth rates. Structural change, which has occurred
over centuries in the advanced economies, has been replicated within a few decades or even
just a few years in developing Asia. One example of such a fast-forward structural change is the
shift from agriculture to manufacturing to services. Another example is the demographic
transition from youthful to older populations. Both the decline in fertility and the increase in life
expectancy have been notable in their speed. Yet another example is the quantum leap in the
technological capacity of some countries in the region.
In general, structural change has a far-reaching impact on inequality. Foreign trade can
exacerbate inequality by rewarding industries and firms which are able to compete in the global
marketplace while punishing those which cannot. Furthermore, in the case of advanced
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economies, imports from low-wage developing countries compete with domestic production of
labor-intensive products, thereby hurting unskilled workers who compete with low-wage workers
in developing countries. This line of reasoning explains the widespread popular belief that
globalization has been one of the key drivers of widening inequality in advanced economies and
also helps to explain the often vehement protests against globalization in those economies.
Technological progress has also been widely put forth as a structural driver of inequality. Skilled
workers are better able to adopt and use new, improved technology than other unskilled
workers, thereby increasing the skill premium and widening the wage gap between skilled and
unskilled workers. Broader structural change, such as demographic transition, can also impinge
upon inequality. In the absence of well-functioning pension systems, demographic change
worsens inequality.
Because structural change in developing Asia has been unprecedented in its scale and speed,
the impact of structural change on inequality in the region is potentially very large. We can
expect the Schumpeterian, revolutionary technological shifts which are constantly rocking
developing Asia’s industrial landscape to even further increase the skill premium and widen the
wage gap between skilled and unskilled workers. Likewise, the region’s high degree of
openness and heavy dependence on trade exposes the region to extensive and frequent
changes in its output mix. The constant change of firms and industries benefits the economy in
the long run but entails serious adjustment costs in the short run. Providing adequate yet
affordable and sustainable old age income support is challenging for the region’s countries due
to the lack of sound and efficient pension systems. In short, since developing Asia is a region in
a flux, in the midst of a wide range of extensive and far-reaching structural changes, we can
expect the impact of those changes on inequality to be potentially extensive and far-reaching as
well.
The rest of this paper is organized as follows. Section 2 provides a conceptual/theoretical
overview of the relationship between structural change and inequality. Section 3 takes a look at
the nexus between structural change and inequality in the advanced economies. Section 4
review and analyzes the nexus between structural change and inequality in developing Asia.
Section 5 concludes the paper with some final observations and policy implications.
2. CONCEPTUAL/THEORETICAL OVERVIEW OF THE
RELATIONSHIP BETWEEN INEQUALITY AND
STRUCTURAL CHANGE
Structural changes in the economy expose the population to challenges and opportunities. The
heterogeneity of the population implies that the adjustment capacity to these changes varies. At
the broad level, the impact of structural changes on inequality is the outcome of the complex
interaction between the initial conditions of a country and five broad time varying channels:
incentives, technological changes, accumulation of physical and human capital, and access to
capital markets and education, social changes and political changes.
2.1
The Five Broad Time-Varying Channels Which Influence the
Relationship between Structural Change and Inequality
We elaborate first on these channels, and provide some examples of the complex interaction
between these channels.
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A1. Economic Incentives
Reforms impact the private incentives. Starting from highly distorted equilibrium, where private
incentives were not aligned with efficient allocation and use of resources, reforms may trigger a
take-off, with large effects on poverty and inequality. The initial take-off may be associated less
with accumulation of capital and the adaptation of new technologies, but with the more efficient
use of existing resources and technologies. The performance of the PRC in the late 1970s and
1980s illustrates the gains of reforms at the level of the community, freeing entrepreneurship
potential and allowing greater private ownership of the resultant surpluses.
Another class of incentives determines the exposure to competitive market forces stemming
from international and interregional trade and the mobility of inputs, mainly capital and labor.
Incumbents frequently engage in policies that may protect their quasi rents, stifling competition
and future growth (Parente and Prescott 2005). These policies include “protection” against
foreign competition by means of commercial policy, protection against the emergence of
domestic competitors by means of red tapes, labor unions opposing immigration and controlling
new hires, etc. Higher exposure to international and interregional trade, and greater input
mobility curb these rent seeking activities, increasing thereby growth. Changing the exposure to
competitive market forces would also impact inequality in numerous ways.
A2. Technological Changes
Technological changes include the adaptation of better technologies, rising productivity via
‘learning by doing’, and efforts leading to technological innovations at the producer and plant
levels (research and development [R&D], etc.).
A3. Accumulation of Physical and Human Capital, and Access to Capital Market and
Education
With the proper incentives, the accumulation of physical and human capital has a large effect on
future income. Unequal access to the capital market and to quality education has profound
implications on income inequality.
A4. Social Changes
The first three factors may impact the household and the community in profound ways. These
are low frequency changes, yet over a span of a generation or two these changes have huge
implications, like changing patterns of gender inequality, fertility, and inducing demographic
transitions. A key development associated with take-offs is the rural-to-urban immigration,
reducing overtime the employment share in rural areas, transforming agriculture from
subsistence family farming into large and efficient corporate production. This transition may
increase urban poverty, impacting income inequality.
A5. Political Changes
Economic take-offs and the resultant changes in social organization and the distribution of
income has been associated with political changes, where the under-represented groups
(women, the poor, periphery, etc…) may gain influence. Similarly, the developing new sectors
may reduce the political clout of the declining sectors. These changes may lead to more equal
access to education, health services, the formation of safety nets, etc.
The quest for stable association between inequality, growth, and these 5 factors is illusive, as in
the long run there is no reason to expect the stability of the relevant feedbacks. Thus,
technological changes may enhance equality if they increase the marginal product of labor, on
the other hand, they may reduce equality if they hollow out the middle class as may be the case
of some of the recent IT trends. Similarly, greater exposure to trade and FDI flows may impact
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the distribution of income in different directions, determined by the initial endowments of
countries. The ability to adapt to the greater penetration of domestic markets by foreign
competition and growing exposure to foreign technologies may determine the ultimate impact of
globalization on income inequality.
To illustrate, in a country with comparative advantage in agriculture, opening the economy to
free trade would increase the price of food, possibly increasing urban poverty and reducing
urban areas real income, with opposite trends in villages producing food. The gross domestic
product (GDP) would increase, but the ultimate impact of free trade on inequality would be
ambiguous. Inequality would increase if most of the population is in the non-farming sector, and
the urban income is below that of the rural areas. The opposite would be the case if poverty is
concentrated in the rural areas. Similarly, the adaption of better technology in agriculture in the
open economy would gradually induce large immigration from the rural-to-urban areas. This in
turn may increase poverty in the urban areas, and on balance would increase the income of
land owners, who may replace rural workers with capital (tractors, trucks, etc.). While the GDP
would increase, the net impact of these changes on inequality is ambiguous.
2.2
Kuznets Curve
The association between inequality and the structural change encompassed in economic growth
is summarized by the Kuznets curve (Kuznets 1955). A decade later, Kuznets (1967) outlined
the link between income distribution, fertility rates, and economic growth.
Dyson and Murphy (1985) documented that the rate of fertility rises before it declines during the
development process. While fertility rates fluctuate, they tend to peak just before starting a
prolonged decline, concluding that the first sign of an impending decline in fertility is a rise,
which often starts many years before the pre-decline peak. These observations were interpreted
by Dahan and Tsiddon (1998) in a growth model with endogenous fertility, deriving
endogenously the demographic transition along with a Kuznets-type dynamics of income
distribution, in a framework where economic growth is based on human capital accumulation. In
line with the Kuznets hypothesis, in the first phase of development, the average rate of fertility
increases and income becomes less equally distributed. In the second phase, fertility declines
and income becomes more equally distributed. The economy also accumulates human capital
more rapidly in this stage. The demographic transition and the U-shaped dynamics of equality
are necessary for knowledge-based growth. A comprehensive analysis of this fertility-human
capital-growth nexus was provided in several papers by Galor and co-authors, and is
summarized in Galor (2005).
Another possible take on the Kuznets curve hypothesis may link it to Lewis (1954)
characterization of economic development. A large share of workers in the poorest countries is
in the rural sector, surviving in close to subsistence level of income earned in low efficiency
framing. Frequently, the takeoff of growth is associated with growing importance of industry and
services in urban areas, offering the prospect of higher income. Yet, the transition from rural
areas to urban environments may come with greater inequality associated with the growing
importance of access to human and physical capitals, the accumulation of which is affected by
differential access of the population to the credit market and to self-financing opportunities. This
suggests that the first stage of growth may increase inequality, especially when it involves
gradual migration from the rural areas to the vibrant urbanized sectors, where differential access
to finance and education, differential abilities and luck is associated with greater inequality. After
decades of growth, the low-income rural sector becomes a minority, and the greater scarcity of
unskilled workers and possibly the adaption of better technologies in farming would increase
their wage, leading to the convergence phase where growth is associated with lower inequality.
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This outcome may be hastened if the political process provides the poor with greater bargaining
clout, inducing greater redistribution and seeding the emergences of a safety net. Brazil is one
of the latest examples for this process.
The evidence on the Kuznets hypothesis is, at best, inconclusive. The cross-section analysis of
countries taken in the 1970s suggests a parabolic relationship in line with Kuznets’ hypothesis.
Focusing on the low and low-middle income countries, Cornia, Addison, and Kiiski (2004) find
that, out of 34 developing countries between the 1950s and the mid-1990s, inequality is higher
in the terminal period for 15 of them, equal for 14 and lower for 5. A U-shape is observed in a
number of cases where inequality is found to be increasing when comparing the terminal and
the initial years. Similarly to the Phillips curve, the scanty empirical evidence validating Kuznets
hypothesis calls for a multi-factor analysis, recognizing that the contribution of the various
factors explaining growth and inequality may change overtime.
2.3
Structural Change, Inequality, and Openness
Lundberg and Squire (2003) focus on whether growth and inequality are simultaneously
determined and whether they are subject to the same set of determining factors. This research
provides answers about the impact of policy innovations on the observed association between
growth and inequality. They show that the determinants of growth and inequality are not
mutually exclusive; however, they did not find variables that robustly uniquely identify the
determinants of growth or of distribution. Consequently, analysis which examines each outcome
independently ignores the evidence that policies designed to improve one outcome will probably
also influence the other. Increasing the Sachs–Warner index to promote growth would lead to
greater inequity, and trade-offs between growth and equality. 1 Improving income distribution
through enhancing civil liberties may have harmful consequences for growth. Their results
suggest that one can derive a set of policies that in combination, may achieve almost any
desired outcome in the growth-distribution space: “Expanded education and more equitable land
distribution will at least improve income distribution, and may also enhance growth. These
policies could be used in combination with an increased value of the Sachs–Warner index to
alleviate the distributional costs associated with “openness”. Thus, growth could be improved
without worsening income distribution by increasing the Sachs–Warner index (that is, increasing
the proportion of time in a given period in which the country satisfies the Sachs–Warner criteria)
by one standard deviation, and simultaneously improving the Gini index of land distribution by
one standard deviation. This combination would nearly double the mean growth rate, and would
also improve income distribution by 4%. These are of course very large policy shifts, but more
modest policy changes could also yield improvements in both growth and distribution.”
Among the structural factors possibly impacting both growth and inequality is international trade.
To a large extent, we can expect FDI to have an analytically similar impact on the relationship
between structural change and inequality as trade, but the literature on the impact of FDI is very
thin so we limit our discussion to the impact of trade. Yet, the channels of the trade effect are
complex, and the quest for clear cut results remains elusive. Attanasio, Goldberg, and Pavcnik
(2004) studied the impact of the drastic tariff reductions of the 1980s and 1990s in Colombia on
the wage distribution. They identified three channels through which the wage distribution was
affected: increasing returns to college education, changes in industry wages that hurt sectors
with initially lower wages and a higher fraction of unskilled workers, and shifts of the labor force
towards the informal sector that typically pays lower wages and offers no benefits. The increase
1
The Sachs and Warner index measures exchange rate and trade policies. It includes measures of exchange rate
overvaluation, tariffs, and non-tariff restrictions on trade.
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in the skill premium was primarily driven by skilled-biased technological changes, partially
motivated by the tariff reductions and the increased foreign competition. Wage premiums
decreased by more in sectors that experienced larger tariff cuts. Sectors with larger tariff cuts
and more trade exposure experience a greater increase in informality. The overall effect of the
trade reforms on the wage distribution may have been minimal.
Recent contributions focus on the impact of trade in the presence of firms and workers
heterogeneity, extending the insightful work of Melitz (2003). Sampson (2011) showed that the
presence of positive matching between worker’s skill and firm productivity explains the employer
size-wage premium and the exporter wage premium. Trade has profound implications of trade
on the resultant matching and income inequality. Under trade, the selection of high productivity
firms into exporting raises the demand for skill and increases wage inequality in all countries,
both on aggregate and within the export sector. This occurs when firm productivity is determined
by a random draw, or when productivity is endogenous to firm level R&D. With endogenous
productivity, the higher demand for skill caused by trade liberalization results from technology
upgrading by new exporters.
The structural changes in developing Asia have been driven by reforms inducing trade and the
specialization of East Asia in manufacturing (information technology [IT] services in India). In
these circumstances, the matching of firms and workers may provide the explanation for the
growing skills premium, and the growing recognition about the importance of investment in
human capital.
2.4
The Influence of Other Factors: Education, Financial Inclusion,
Infrastructure, Governance and Institutions
While estimating the impact of international trade on the rise of skill wage premium and
inequality remains a work in progress, existing evidence is validating these forces. Castelló and
Doménech (2002) computed the Gini coefficients and the distribution of education by quintiles
for 108 countries over five-year intervals from 1960 to 2000. They found that human capital
inequality negatively influences economic growth rates not only through the efficiency of
resource allocation but also through a reduction in investment rates. Overall, education
inequality is associated with lower investment rates and, consequently, lower income growth.
Therefore, policies conducted to promote growth should not only take into account the level but
also the distribution of education. Consequently, aiming at a universal access to quality
education opt to reduce both inequality and increase economic growth. 2 This task is
complicated by the public sector support required to move towards universal access to quality
education, as the cost of such education is beyond the reach of a large fraction of the
population. Furthermore, greater inequality implies that wider segment of the population is
unable to fund quality education, requiring deeper commitment of the public sector. While the
fiscal challenges associated with funding education are daunting, experience of countries
reviewed in the next sections suggests that major strides in improving access to education have
been accomplished within a generation or two in countries starting with low tax base.
Financial access and financial inclusion can influence the relationship between structural
change and inequality. More specifically, it can mitigate the adverse impact of structural change
2
The focus on quality of education follows the work of Hanushek and Woessmann (2010), finding that there is strong
evidence that the cognitive skills of the population—rather than mere school attainment—are powerfully related to
long-run economic growth. The relationship between skills and growth proves extremely robust in empirical
applications. Growth simulations reveal that the long-run rewards to educational quality are large but also require
patience.
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on inequality. For example, a higher level of financial access and inclusion will reduce the
adjustments costs of firms and individuals who are dislocated by opening up the domestic
economy to foreign trade and FDI. The underlying reason is that they are better able to reallocate to new industries and activities. The same logic applies to adjustment to dislocation
arising from technological progress. One concrete and specific example is the capacity of laidoff workers to finance their training and re-training which would help them to find new jobs.
Another significant determinant of the relationship between structural change and inequality is
infrastructure which raises economy-wide productivity and thus facilitates the re-allocation of
resources in the face of structural change. Finally, the quality of governance and institutions can
also reduce the negative effect of structural change on inequality. In particular, stronger
governance and institutions will facilitate the provision of public assistance to those who are
adversely affected by structural change. Flexible product and labor markets will also help.
While the link between higher inequality and lower growth may be tenuous in the short-run, the
adverse effects of inequality on future growth may emerge. Growing income inequality seeds
growing discontent, leading to future political and economic instability (Alesina and Perotti
1996). Evidence shows the negative effect of economic volatility on private investment and
economic growth (Aizenman and Marion 1993, 1999; Ramey and Ramey 1995). Thereby,
access to quality education would increase growth directly, working towards mitigating income
inequality, and would reduce the downside risk of the future emergence of growth reduction
economic instability.
3. INEQUALITY-STRUCTURAL CHANGE NEXUS IN THE
ADVANCED ECONOMIES
Insight can be gained by tracing the inequality-structural changes in advanced countries during
the last 200 years. As developing Asia is converging to the development level of the advanced
countries, the experience of the OECD countries may provide insight on the inequality-structural
change associations during varying stages of growth and convergence. 3
The history of Europe, England being among the best documented examples, provides useful
lessons. In the first phase of the Industrial Revolution, prior to the implementation of significant
education reforms, physical capital accumulation propagated by technological improvements
was the prime engine of economic growth. In the absence of significant human capital
deepening, the concentration of capital among the capitalists widened wealth inequality. The
industrialization set in motion a process whereby the increase in the return to labor relative to
capital, and the higher demand for skills propagated education reforms. In the second phase of
the Industrial Revolution, the pace of capital accumulation sharply decreased, whereas the
education of the labor force increased, and skills became necessary for production. The
investment ratio increased in England from 6% in 1760 to 11.7% in 1831, remained at around
11% on average in the years 1856–1913 (Crafts 1985; Matthews et al. 1982). In contrast, the
average years of schooling of male in the labor force was overall stable until the 1830s, tripled
by the beginning of the 20th century (Matthews et al. 1982: 573). 4 All these changes, and the
3
4
See Galor (2005), Parent and Prescott (2005), and Maddison (2008) for comprehensive overviews of long-run
growth patterns.
Education reforms in England followed the pressure by capitalists as well as labor unions, which recognized the
importance of technical skills for maintaining competitiveness against other European countries. The 1889
Technical Instruction Act allowed the new local councils to set up technical instruction committees, and the 1890
Local Taxation Act provided public funds that could be spent on technical education (Green 1990).
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associated accumulation of assets by the workers, brought a gradual decline in inequality
(Wiliamson 1985; Clark 2002, 2003).
Education reforms in the second phase of the Industrial Revolution were associated with a
sharp increase in real wages along with a sharp increase in the wage–rental ratio. Over 1823–
1915, wealth inequality in the United Kingdom (UK) peaked around 1870 and declined
thereafter, in close association with the sharp increase in the enrollment rates of children in
public primary schools from about 20% in 1870 to about 80% in 1910 (Flora et al. 1983). During
that period, wages almost doubled, with mild changes in land and rental rates. The decline in
inequality was associated with sizable changes that occurred around 1870 in the relative returns
to the main factors of production possessed by capitalists and workers. The changes in factor
prices reflect the capital accumulation triggered by technological innovations inducing higher
demand for skilled workers, as well as the increase in enrollment rates and its delayed effect on
the skill level per worker. Similar patterns were observed in France and Germany (Morrisson
and Snyder 2000). The decline in inequality in France appears to be associated with the
significant changes in the relative returns to the main factors of production possessed by
capitalists and workers in the second part of the 19th century. Levy-Leboyer and Bourguignon
(1990) documented that real wages and the wage–rental ratio increased significantly as of
1860, reflecting the rise in the demand for skilled labor and the effect of the increase in
enrollment rates on the skill level per worker.
The transformation of employment from agriculture to industry and services has been a key part
of the growth process triggered by takeoffs, with massive rural to urban reallocation of
population. In the UK, the employment share of agriculture dropped from about 35% in 1800, to
5% in 1950, reaching below 3% today. The results are more dramatic for the United States
(US), where the agriculture employment share at the beginning of 1800 was well above 70%,
reaching about 2% today. For late comers to the industrialization, this process accelerated: the
agriculture employment share dropped in Spain from about 67% in 1900, to well below 10%
today. This process was driven by two factors: improvements in agricultural technology
combined with Engel’s law release resources from agriculture (labor push from agriculture), and
improvements in industrial technology attracted labor out of agriculture (labor pull). Empirical
analysis of 11 Organisation for Economic Co-operation and Development (OECD) countries,
since 1800, suggests that the “pull” channel dominated until about World War II, with the “push”
channel dominating afterwards. The “pull” channel seems to matter more in countries in early
stages of the structural transformation (Gollin et al. 2002; Alvarez-Cuadrado and Poschke
2011).
Wealth inequality in the US, which increased gradually from colonial times until the second half
of the 19th century, reversed its course at the turn of the century and maintained its declining
pattern during the first half of the 20th century (Lindert and Willamson 1976). The emergence of
the “new economy” in the early 20th century increased the demand for educated workers. In
tandem, the creation of publicly funded mass modern secondary schools from 1910 to 1940
provided general and practical education, contributed to workers’ productivity, and broadened
college education (Goldin 2001), facilitating social and geographic mobility. It generated a large
decrease in inequality in economic outcomes. This process was magnified by the onset of
demographic transitions.
The industrial revolution in Western Europe set in motion a complex process of demographic
transition. While the growth rate of output/capita increased in the first phase of the industrial
revolution, the Malthusian effect of income per capita on population growth was maintained for a
transitional period. During that period, the sizable increase in population growth mitigated some
of the potential gains in income per capita. In England, the acceleration in technological
progress and the accumulation of physical capital, and to a lesser extent human capital,
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generated a gradual rise in real wages in the urban sector. Partly due to labor mobility and
demand effects, it induced a gradual rise in real wages in the farming sector. The relaxation in
the households’ budget constraint following the takeoffs was associated with an increase in
fertility rates along with an increase in literacy rates and years of schooling. Concurrently with
the decline in mortality rates, fertility rates and population growth increased in most of Western
Europe until the second half of the 19th century (Coale and Treadway 1986). The take-off was
associated with the acceleration in industrialization and rise in urbanization, and a persistent
decline in the share of agriculture production in total GDP (Mitchell 1981; Bairoch 1988). The
increasing skill requirements in the process of industrialization increased the demand for
education, which was boosted also by the significant increase in life expectancy. Overtime, the
contribution of human capital accumulation to the growth process increased (doubled in the
US), whereas the contribution of physical capital declined significantly (Goldin and Katz 2001).
Following the growth takeoff, population growth rate accelerated. However, with a significant lag
(about a century in Western Europe, about 70 years in the US, Canada, and Australia), there
was a dramatic drop of population growth rate (Maddison 2001). The decline in population
growth followed the dramatic decline in fertility rates, reaching in Europe levels well below the
population replacement level. Importantly, the decline in fertility during the demographic
transition outpaced the decline in mortality rates, and brought about a decline in the number of
children who survived to their reproduction age. While this process fits well the secular increase
in the demand for human capital, it may induce higher inequality if the demographic transition is
distributed unevenly, tilted towards the higher end of the income distribution.
The process of industrialization in developed economies was magnified by the growth of
international trade. The UK and Northwest Europe were net importers of primary products and
net exporters of manufactured goods, whereas the exports of Asia, Oceania, Latin America, and
Africa were overwhelmingly composed of primary products (Findlay and O’Rourke 2003).
O’Rourke and Williamson (2005) found that trade was a significant force behind the rise in
productivity in the UK. Therefore, while technological advances could have triggered the
Industrial Revolution without an expansion of international trade, the growth in exports
increased the pace of industrialization and the growth rate of output per capita of the UK and
Western Europe.
Common threads of these experiences were that the accumulation of physical capital raised the
role of human capital in the growth process, reflecting the complementarities between capital
and skills. Investment in human capital, however, was sub-optimal due to credit market
imperfections. Limited access to and affordability of quality education, where wealth, gender,
race, and ethnicity affected schooling availability propagated unequal accumulation of human
capital, inducing rising inequality at times of higher average real wages. Consequently, deeper
public investment in education has been growth-enhancing, reducing income inequality.
However, the low degree of complementarity between human capital and land during the
industrial revolution implied that universal public education increased the cost of labor beyond
the increase in average labor productivity in farming, probably reducing the return to land. 5
International trade enhanced the specialization of industrial economies in the production of
manufacturing and other skilled intensive goods during the second phase of the Industrial
Revolution. The resultant rise in the demand for skilled labor induced a gradual investment in
the quality of the population, expediting a demographic transition, probably stimulating follow up
5
Therefore, landowners had limited economic incentives to support growth enhancing educational policies as their
stake in the productivity of the industrial sector was insufficient. Thus, an unequal distribution of land ownership put
a drag on the support and the accumulation of human capital (see Galor, Moav, and Vollrath 2003).
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technological progress, and further enhancing the comparative advantage of Western Europe in
the production of skilled intensive goods. In contrast, in non-industrial economies international
trade has generated the opposite forces—greater specialization in non-industrial goods,
produced by unskilled, low wage works. The resultant low demand for human capital has
provided limited incentives to invest in the quality of the population. Therefore, the gains from
trade in non-industrial economics probably delayed their demographic transition, increasing
further their relative abundance of unskilled labor. Consequently, international trade affected in
complex ways the distribution of population, skills, and technologies in the world economy.
The degree to which the education system and the social norms allow wide accessibility to
human capital accumulation is a key factor accounting for the impact of structural changes on
the distribution of income. Quality private education is frequently beyond the reach of the poorer
segment of the population. Capital market imperfections associated with the inability to
collateralize human capital implies that public funding and public education are critical for the
wide accessibility to education. The history of Western Europe, Canada, and the US suggests
that, in the second phase of the industrial revolution, the emergence of public education and
greater labor mobility facilitated growth accompanied by lower inequality.
Nevertheless, the rosy outcome of growth with lower inequality in the second phase of the
industrial revolution is not reassured. Widely available quality public education requires
significant tax support, redistributing income towards the poorer segments of the population.
Popular support for redistributive policies may decrease with inequality (Benabou 2000). With
imperfect credit and insurance markets some redistributive policies can improve ex ante
welfare, and this implies that their political support tends to decrease with inequality.
Conversely, with credit constraints, lower redistribution translates into more persistent
inequality; hence the potential for multiple steady states, with mutually reinforcing high inequality
and low redistribution, or vice versa. Benabou’s framework also provides an interpretation for
the documented negative relationship between initial disparities of income or wealth and
subsequent aggregate growth (Alesina and Rodrik 1994; Persson and Tabellini 1994).
Recognizing that pretax inequality has a significantly negative effect on social transfers (De
Mello and Tiongson 2006), it follows that greater inequality may hinder the support for quality
public education and overall accumulation of human capital, reducing thereby growth.
The rise in inequality in the US from 1980 may represent a new development phase, associated
with technological changes propagated by the ongoing IT innovation. Autor et al. (2008) explain
the rise in US wage inequality since 1980 as the outcome of two trends. First, the rapid secular
growth in the relative demand for skills, attributable to skill-biased technical change, and a sharp
deceleration in the relative supply of college workers in the 1980s capture well the evolution of
the college/high school wage premium over four decades. Second, the recent “polarization” of
skill demands in which employment has expanded in high-wage and low-wage work at the
expense of middle-wage jobs may reflect the role of information technology in complementing
abstract (high-education) tasks and substituting for routine (middle-education) tasks. The
authors conclude that computerization and international outsourcing may have raised the
demand for skill among higher-educated workers, depressed skill demands for “middleeducated” workers, while leaving the lower end of the wage distribution comparatively intact.
This interpretation may account for the “hollowing out” of the wage distribution observed in
OECD countries.
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4. ANALYTICAL REVIEW OF THE INEQUALITY-STRUCTURAL
CHANGE NEXUS IN DEVELOPING ASIA
The global trend since the 1960s has been the ‘catch-up’ and convergence across countries
(Maddison 2008). Developing Asia has led this trend, with unprecedented growth of the
GDP/capita from 1952 to 1978 in Japan; Taipei,China; the Republic of Korea; Hong Kong,
China; and Singapore, at annual rates ranging between 4.8% (Singapore) to 6.7% (Japan). The
next step was the tectonic shift propagated by the takeoff of the PRC in the 1980s followed by
India in the 1990s. A common feature of these takeoffs has been the high levels of investment
in human and physical capital, rapid increases of international trade and inflows of FDI, and the
transfer of technology. In most Asian takeoffs, the leading sectors were manufacturing (services
in India). The rapid growth rates following these takeoffs were reinforced by large investment in
physical and human capital, financed by very high investment and saving rates in developing
Asia.
The experience of developing Asia differs from that of emerging Latin America, in the key role
played by export led growth strategy, with heavy emphasis on industrialization. Frequently, this
strategy was supported by direct allocation of available credit by state-owned banks, in ways
linked to the realized growth and export performance. Japan (from the 1950s) and the Republic
of Korea (from the 1970s) are among the countries that used these credit policies for several
decades, applying elaborate institutional mechanisms for selection and monitoring (World Bank
1993). The growth was also propagated by trade liberalization efforts, increasing the SachsWarner index of openness, resulting with a large increase in investment, growth, and exports
(Wacziarg and Welch 2008). Intriguingly, Japan and the Republic of Korea were closed to
inward FDI, and refrained from large hoarding of international reserves during the first decades
of their economic takeoffs. The emergence of manufacturing as a leading sector provided the
pull factor for the rural-to-urban migration. The agriculture sector in developing Asia managed to
increase its productivity in tandem with the growth takeoff. This was the outcome of land
reforms, notably in the Republic of Korea and Taipei,China, improvement in agriculture
extension services to speed the diffusion of Green Revolution technologies, and investment in
infrastructure (World Bank 1993). Thus, in the first stage of the takeoffs, growth benefits
reduced poverty across the board. Yet, the preferential treatment of industrialization imposed an
implicit tax on agriculture, resulting with lagged income growth in the rural relative to the more
industrialized, mostly urban areas.
The experience of the last three decades in the PRC differs from that of Japan, the Republic of
Korea, and other developing Asian countries in the key role of inward FDI and joint ventures.
These activities facilitated more rapid technological transformation. International trade remains a
vital part of the PRC’s growth strategy, with growing role for complex network-trade with the
Republic of Korea, Japan, and other Asian countries. The strategy seems to work, allowing the
PRC to climb rapidly on the ladder of product sophistication, at rates faster than the one
observed earlier in Japan, the Republic of Korea, and other developing Asian economies
(Schott 2008). FDI inflows to the PRC may contribute to greater inequality, as the geographical
distribution of the inward FDI has been skewed towards the Eastern-Southern provinces.
Fleisher, Li, and Zhao (2010) pointed out that FDI had a much larger effect on total factor
productivity (TFP) before 1994 than after, attributing this finding to the increasing success of
private and quasi-private enterprises. Regional differences in physical, human and infrastructure
capital, and regional differences in FDI flows account for the differential regional growth
patterns. Human capital investment in less-developed areas is justified on efficiency grounds
and because it contributes to a reduction in regional inequality.
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While the export led growth strategy may fit small countries, short of the emergence of a “new
demander of last resort,” the PRC’s growth path has been challenged by its own success
(Aizenman and Sun 2010). This is especially the case at times of diminishing growth prospects
of the US and the euro area. Feenstra and Hong (2010) concluded that the growth in domestic
demand led to three-times more employment gains than did exports over 2000–2005.
Therefore, the PRC could turn towards domestic demand instead of export and consumer
expenditures, in particular as an engine to stimulate employment. The policies associated with
such a turn would reduce the inequality between the urban and the rural areas.
This intriguing observation is in line with the growth performance of India, which managed to
grow fast in a more balanced way, without relying on external demand as the engine of growth.
India’s growth takeoff took place against a background of prior inequality in access to
opportunities and income, which in turn put a drag on the speed of poverty reduction, and
probably magnified the increase of inequality. The prior inequality in India, and the higher
growth rate of the PRC, accounts for the faster poverty reduction accomplished by the PRC
(Ravallion 2011).
The inequality debate in India is generally discussed in relation to the major economic reforms
in the 1990s. India underwent radical external sector liberalization—average manufacturing
tariffs dropped from 117% in 1990–1991 to 39% in 1999–2000. Trade reforms, among other
structural reforms, and economic growth has reduced poverty in India and important drivers
were technological changes in the rural areas (Datt and Ravallion 1998). Nevertheless,
geographic and sector divergence in India’s growth process, and heterogeneous access to
opportunities dampened the poverty reduction effect of growth (Datt and Ravallion 2002, 2009).
The remarkable increase in the growth rate triggered by takeoff was helped occasionally by the
ability to “leapfrog,” bringing advanced technologies to communities that were not exposed to
the gains from older technologies. The fast adaptation of cell phones and IT networking in
communities without access to reliable phone lines allowed India to become a key global
provider of back office and software services, despite its infrastructure deficits. 6 As much of the
service sector’s growth comes from relatively skill-intensive subsectors such as IT, process
outsourcing, and financial services, this growth contributed more to the well-educated and
households with better access to schools and colleges. The relatively small employment share
of services and manufacturing in India accounts for the increased inequality in recent decades.
Kumar and Mishra (2008) provided evidence that trade liberalization in India led to decreased
wage inequality between unskilled and skilled workers. Hasan and Mehta (2011) find that most
of the shift in inequality cannot be attributed directly to liberalization. They find that 29% of the
change in wage inequality from 1993 to 2004 can be attributed to liberalization, 25 points of
which is linked to services reforms and 4 percentage points is due to trade liberalization.
Burua and Chakraborty (2010), on the other hand, find positive relationship between trade
openness and interregional inequality. India experienced a higher rate of increase in income
inequality across the country during the post-reform period (1995–2000) as India’s openness
increased, interregional income inequality also elevated due to the concentration of
manufacturing in the metropolis area.
In Malaysia, inequality, particularly between races, was given specific attention in policy making
in the aftermath of the racial turbulence in the late 1960s. The government put emphasis on
diversifying agriculture output and export-oriented manufacturing to facilitate growth and
6
While leapfrogging may allow overcoming infrastructure deficiencies, the degree to which countries may leapfrog in
a wide range of manufacturing remains debatable (see Hobday 1994). Yet, the development patterns of the PRC
suggest that climbing very fast on the quality ladder is feasible.
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increase employment opportunities. The government also focused on education and human
resource development.
Further liberalization and deregulation during the period 1991–1995 facilitated the decline in
poverty incidence by 9.6%, helping more than 400,000 individuals out of poverty. Income
inequality during this period, however, increased by 4.3%. Ragayah (2008) points to the
government’s liberalization and privatization policies after the mid-1980s as the reason for
worsening inequality since 1990. Concerns that wage increases in the early 1990s would erode
exports uncompetitive induced policy makers to open the economy to foreign workers who kept
wages down. The resultant depressed wages deteriorated the income distribution.
The Asian financial crisis of 1997–1999 induced a decline in inequality, apparently because the
crisis affected adversely more the top quintiles of the households. The impact on the bottom two
quintiles was rather mild, as the crisis did not lead to massive unemployment for the locals while
shortly after the crisis, inequality resumed the upward trend. Malaysia’s preferential treatment of
the Bumiputra (indigenous people of Malay) seemed to reduce poverty and inter-ethnic income
disparity, yet intra-ethnic income inequality has widened.
In post-crisis years, Malaysia has been experiencing growth of about 5–6% with no significant
improvements in the unemployment rate. In order to maintain its competitiveness in the global
market, it has been moving from labor-intensive towards capital- and technology-intensive
production.
Consequently, the demand for skilled and highly educated workers increased, pushing up their
wage relative to that of the unskilled workers, increasing inequality. This may reflect the
maturing of the Malaysian economy, climbing up the value chain, substituting labor-intensive
operations to skill/knowledge-intensive activities. Intriguingly, these interpretations are
reminiscent of the development in the US discussed in the previous section.
Most Asian economies are characterized by their dual economic structure, where the agrarian
sector engaged in subsistence farming. Thereby, the adaptation of better farming technologies
has the byproduct of pushing the surplus labor to the urban areas. Transferring more than half
of the population from rural to urban communities took about 100 years in Europe, yet the faster
convergence of East Asia implies that this transformation may happen within less than 50 years.
The challenges associated with this transformation are enormous, as it’s not obvious that the
push forces inducing rural labor to move to cities (better farming technologies) would match the
pull forces (higher demand for labor in manufacturing and services, mostly concentrated in
rapidly growing urban communities). As the pull factors may play a greater role at the first stage
of economic development, the transition may impose key economic and social challenges.
While restrictions on labor mobility may help in the first stages (see the PRC’s experience), it
may lead to segmented labor markets, with growing underclass of discontent workers. The fast
industrialization experienced in developing Asia implies also a rapid increase in the demand for
skilled workers, leading to bottlenecks, with widening wage gaps between skilled and unskilled
workers. Distortions associated with uneven access to the capital market and education may
expose Asian countries to faster increases in wealth and income inequalities, and may put a
drag on the sustainability of fast growth.
The PRC’s experience provides a key case study of the five forces shaping growth and
inequality dynamics described in Section II. Changing economic incentives induced by reforms
of the early 1980s induced rapid growth in the rural economy, and accounted for the majority of
the PRC’s success in poverty reduction since 1980 (Ravallion and Chen 2007). The rapid
industrialization of South-Eastern provinces, facilitated by selective incentives, FDI inflows and
the export led growth strategy induced rapid technological changes and accumulation of capital.
The combination of these factors led to massive migration from rural towards the growing
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industrialized urban centers in South-Eastern PRC, and the growth of urban poverty (Li 2006;
Knigh et al. 2007). The process was shaped by the initial conditions of the PRC, including the
hukou system. 7 Its power in controlling people's life has declined in the reform era in the wake
of enormous social and economic changes and dramatic rise in rural-to-urban mobility. Despite
all the reforms, the system still functions to constrain personal free migration and contribute to
societal segregation. The gross inequality of the system has triggered a political and social
process, putting in motion a slow trend toward further relaxation of the nongzhuanfei process
(i.e., the process of converting the hukou status from agricultural to non-agricultural one). The
growing demand for human capital, labor market pressures, and the social fragmentation may
provide the impetus for further reforms.
The fast initial growth rates of developing Asia observed during the second half of the 20th
century may also imply faster demographic transitions. This reflects several factors: modern
technology allowing gender screening and selective abortions; the enforcement of the “one
Child policy,” in the PRC; and the rapid drop in infant mortality propagated by adopting modern
medical standards. This is in contrast to the slower demographic transitions in Western Europe,
where the control mechanism impacting the family size in the 19th was endogenous adjustment
of female’s age of marriage (Wrigley and Schofield 1981). Consequently, developing Asia has
been moving faster than Western Europe throughout the paces of demographic transition. This
may account for the increase of FDI outflows from Japan in recent decades, needed to
compensate for its shirking and expensive labor force, possibly increasing the wage inequality
between workers and owners of capital. Similar challenges would affect the PRC, the Republic
of Korea, and other countries projected to enter the stage of rapid increase in the old
dependency ratio within less than a decade. 8
The dilemma facing developing Asia is that “While the developed countries became rich before
they became old, the developing countries will become old before they become rich” (Harlem
Brundtland, former Director-General of the WHO). The growing inter-generational tension
associated with rapidly aging societies would aggravate the drag on the growth rate of
developing Asia. While there are no quick and easy fixes to demographic challenges, there exist
possible policies that may mitigate the downside risks:
(i)
(ii)
7
8
Key importance for deepening equal access to quality publicly supported education.
This would facilitate faster growth and act to mitigate the rising inequality.
Minimizing the debt overhang associated with unfunded liabilities, and improving the
foreign asset position of developing Asia would help. Stockpiling foreign assets in the
form of international reserves well above 15% of the GDP, a common practice in
most developing Asia, may be sub-optimal. A better policy stance may involve
diversifying reserves into well run Sovereign Wealth Fund, investing globally in
equities.
The Chinese household registration system (hukou) divides the population into “agricultural” and “nonagricultural”
sectors. It may be the most important determinant of differential privileges in state socialist PRC, determining
access to good jobs, education for one’s children, housing, health care, and even the right to move to a city (Wu
and Treiman 2004). Transforming one’s hukou status from rural to urban is a central aspect of upward social
mobility. Education and membership in the PRC Communist Party are the main determinants of upward social
mobility.
The Republic of Korea’s speed of population ageing has been unprecedented. The average fertility rate (birth per
woman) is by now about 1.3, among the lowest in the world. The By 2050, the median age of the population of the
Republic of Korea is projected to be 57 years, making it one of the most elderly nations in the world. In contrast, at
present, Japan has the oldest median age at 43 years, while Korea’s stands at 37 years (Klassen 2010).
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(iv)
Aizenman, Lee, and Park
Policies that would reduce the private cost of rearing kids would help. Access to
quality public education is important, but one should go beyond this. Dealing with
the root causes of the tendency to “overeducate” kids due to a “rate-race” to top
universities would be useful. 9 Other steps reducing the burden of rearing kids, which
is typically born by the mother, may help in mitigating the collapse of child bearing in
developing Asia.
Adopting policies that are friendlier to immigrants would help. This would be
especially helpful in smaller countries (for the experience of Singapore and Malaysia,
see Ruppert 1999), but it would alleviate bottlenecks even in large countries.
Arguably, developing Asia can apply its monopsony power to encourage a human
capital profile of its immigration and foreign labor that would fit its economic
aspirations and challenges, as has been the practice of Canada and Australia.
5. CONCLUDING OBSERVATIONS AND POLICY
IMPLICATIONS
Structural change—or changes in the structure of the economy or broader changes in noneconomic, political, social, cultural, or other spheres—has a major impact on inequality. Greater
openness to foreign trade intensifies competition and thus accelerates changes in a country’s
industrial structure and output mix. In the short run, openness increases adjustment costs since
some industries and firms will be unable to withstand foreign competition. Analogously,
technological progress will benefit more skilled workers who are able to use the new and
improved technology but disadvantage less skilled workers. In the process, the skills premium
will increase, widening the wage gap between the two groups of workers. Structural change
exerts a significant effect on inequality in both advanced and developing countries. What sets
developing Asia apart from the rest of the world is not the close link between structural change
and inequality but the sheer speed and scale of structural change. Extensive structural change
is both a cause and consequence of the exceptionally rapid economic growth, which enabled
the region to raise living standards and reduce poverty at a historically unprecedented rate.
Our review of developing Asia’s experience confirms that the region has experienced seismic
structural change during its growth and development process. Of course, each country faces
different structural changes and the relative importance of a given structural change differs
across countries. Furthermore, even for the same country, a given structural change can
become more or less important over time. For example, the increase in inequality arising from
the PRC’s transition from a centrally planned economy to a market-oriented economy is
becoming less important as it moves farther away from the market reforms of 1978. In the case
of Malaysia, the economically disadvantaged position of the majority Malay population has
traditionally been a main source of inequality. In response, the government has implemented
discriminatory policies, which explicitly sought to help the majority Malays bridge the income
gap with the other ethnic groups. A relative high level of illiteracy stands in the way of India’s
efforts to make growth more inclusive. India differs too from its poor infrastructure which
impedes inter-regional connectivity and thus impedes inter-regional income convergence. In
short, while many countries in developing Asia are buffeted by structural changes which impinge
9
The Republic of Korea is a sad example of this situation, though the “rate race” distortion applies well beyond the
Republic of Korea. According to Chang (2008: 3), “All told, astronomical amounts of educational resources are
grossly misallocated because of the failure of public education. While these resources turn into a deadweight loss
or social waste, much of the public education infrastructure remains substandard.” This waste included running
“education trade deficit” of US$ 4.4 billion in 2006, projected to increase at a rate of 30% annually.
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upon inequality, the relative importance of different structural changes differs across countries
and, for a single country, over time.
Given the interconnectedness between different types of structural changes, what separates
developing Asian countries matters less than what unites them, namely the collective scale of
the structural change confronting them. At a broader level, structural change entails adjustment
costs. Therefore, addressing the inequality resulting from structural change requires mitigating
those adjustment costs.
Developing Asia has already begun the difficult and complex task of addressing inequality
arising from structural change. In response to growing popular demand for more equity,
governments across the region are seeking to include more of the population in the growth
process and spread the fruits of growth to more of the population. While the dominant growth
philosophy among the region’s governments in the past was “grow first, redistribute later”, there
is now a growing recognition that more sustainable growth supported by broad-based political
and social support requires a growth strategy, which provides equality of opportunity, especially
in education and employment. The newly developing more inclusive growth philosophy also
envisions expanded social protection systems and social safety nets to protect the poor and the
vulnerable. Although this new growth philosophy is geared toward reducing inequality and
promoting equity in general, the fact that structural change is likely to be a major source of
inequality in developing Asia re-confirms and validates the basic direction of the philosophy. The
fundamental solution to mitigating the adjustment costs arising from structural change lies in
empowering individuals to become more productive, adaptable, and versatile through access to
education and employment.
Finally, the experiences of the advanced economies entail a number of valuable lessons for
developing Asia. First, the impact of the adaptation of new technology on income inequality is
frequently large, varying depending on initial conditions and the nature of the technology. While
some technologies lead to widespread gains and higher equality, some may lead to greater
inequality generating losers and gainers, with “hollowing out” effects. Second, international trade
reinforces the take-off and growth in economies where manufacturing is the leading sector.
Faster technological adaptation magnifies growth, and benefits from aggressive education drive.
On the other hand, new technologies tend to generate winners and losers, and may increase
inequality. Third, ensuring equal access to quality public education is extraordinarily important.
This would facilitate faster growth and act to mitigate the rising inequality that characterizes the
first phase of takeoffs. Fourth, the downside of growing Inequality is breeding socio-political
instability and lower economic growth. Quality public education helps, but at the second stage of
the growth takeoff, state-sponsored safety net would mitigate the downside risk of growing
inequality. Safety net would also reduce the opposition to rapid changes and the adaptation of
new technologies. Fifth, demographic transitions following a successful takeoff are unavoidable,
imposing new challenges. While the drop in net fertility opts to increase the investment in
human capital, the final phase of the demographic transition may impose acute fiscal
challenges. Widening the tax base and curbing unfunded liabilities help in avoiding stagnation.
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